Energy costs are an unavoidable reality facing a broad spectrum of industries. For example, if you’re involved in transportation, agriculture, or even retail, it’s likely that you have a line item on the monthly budget exclusively for energy.
Energy plays a key role in almost every industrial sector. In many ways, it is the lifeblood of a developed nation’s economy. As a result, the relative performance of a wide range of industries — particularly utility providers, petroleum and refining services, and shipping/freight — is highly sensitive to fluctuations in the energy markets:
In order to insulate operations from the impact of energy pricing volatility, many business owners look to hedging with futures for a solution. Whether seeking insurance against a harsh winter or high fuel prices, standardized futures contracts can help mitigate a variety of foreseen and unforeseen risks.
Energy: Available Futures Products
The Chicago Mercantile Exchange (CME) offers participants in energy-sensitive industries numerous options for hedging risk. Contracts facing a variety of refined and unrefined products are readily available for active trade.
| Product | Symbol | Description |
|---|---|---|
| WTI Crude Oil | CL | Light, sweet crude oil |
| Henry Hub Natural Gas | NG | Natural gas |
| RBOB Gasoline | RB | Gasoline fuel |
| NY Harbor ULSD | HO | Heating oil/ultra-low sulfur diesel |
| PJM Western Hub Peak-Month | AL1 | Electricity |
In addition to the popular energy commodities contracts, there are several other “exotics” that are also used to diversify against risk. Contracts facing coal, propane, ethanol, and biodiesel are traded with less liquidity but remain viable hedging instruments.
Hedging Strategies: The Consumer/Producer Paradigm
Depending upon the industry, sensitivity to energy pricing varies wildly. Transportation, shipping, and similar sectors rely greatly on the pricing stability of refined fuels. On the other hand, companies in the oil and gas services industry benefit from higher prices in energy commodities.
In effect, this relationship illustrates the consumer/producer paradigm. While one group benefits from high energy prices, the other does not. However, no matter whether a party views high or low energy pricing as advantageous, hedging with futures can be a viable avenue of managing risk.
| Business | Energy Position | Exposure (Risk) | Hedge (Symbol) |
|---|---|---|---|
| Corn Farmer | Consumer | Rising fuel prices | Long RB, HO |
| Airline | Consumer | Rising fuel prices | Long HO |
| Motel/Hotel | Consumer | Rising energy costs | Long AL1 |
| Petroleum Services | Producer | Falling energy pricing | Short CL, NG |
| Utilities | Producer | Falling energy pricing | Short NG, HO |
The goal of a consumer hedge is to protect against instability in the refined fuels or electricity market. A futures contract can be very helpful, in that a large scale consumer, such as an airline or a corn farmer, can “lock in” fuel pricing for an upcoming period. For instance, a corn farmer may buy the New York Harbor Low-Sulfur Diesel (HO) contract at the current market price in an attempt to insulate against a coming hike in diesel. If storage options are available, the farmer may elect to take delivery at contract expiry for use; if not, the contract is sold at market with gains offsetting the rise in fuel costs.
Conversely, energy producers are faced with the opposite problem. In the case of plummeting oil prices, a driller or oil field services provider may choose to take a short position in a related WTI Crude Oil (CL) contract. Gains from the open position may be used to reduce the impact of falling oil prices on operations. Large-scale producers may even elect to make delivery on the contract instead of liquidation to maximize the net benefit at contract expiry.
Active Hedging
Understanding the impact that energy has upon your business can be a complicated task. Fuel and commodity pricing are sometimes merely the tip of the iceberg. Consultation with an experienced energy expert is a great place to begin quantifying what energy means to your bottom line.
For a free consultation on how the futures markets may bring value to your operation, contact the team at Daniels Ag Marketing.
